07-22-2005, 06:05 AM
2% Solution
China Lets Yuan Rise vs. Dollar, Easing Trade Tensions Slightly
Amid Pressure From U.S., Beijing Links Economy More to Market Forces Greenspan: 'Good First Step'
By James T. Areddy in Shanghai, Mary Kissel in Hong Kong, and Andrew Browne and Michael M. Phillips in Washington July22,2005
China announced a long-awaited currency-policy change with broad symbolic significance, integrating the nominally Communist nation more deeply into global markets and helping ease tensions with trading partners.
The People's Bank of China revalued the yuan to make the Chinese currency effectively 2.1% stronger against the American dollar than it had been for years. That went part way to satisfy critics who say the yuan has long been significantly undervalued, making Chinese goods cheaper abroad and thus giving the Chinese an unfair trading advantage.
The question is whether the move will be enough -- both to give Beijing's economic stewards the flexibility to deal with weaknesses in their own economy and to quell rising anti-Chinese sentiment around the world.
The answer hinges a lot on just how flexible Chinese currency policy really becomes. The announcement on state television Thursday night in Beijing, at about 7 a.m. New York time, didn't say.
China said it would no longer peg the yuan's value only to the dollar, instead allowing it to trade within a narrow band against a basket of currencies. But just how much the yuan's value will be market-driven, as opposed to government-driven, remains unclear. As the central bank put it in its statement, the Chinese government will act "with a view to establish and improve the socialist market economic system."
The result was a cautious response from American policy makers who have long been prodding China to act. "I think it's the start of an awfully important process," said Treasury Secretary John Snow. Speaking to reporters, he said he was "particularly struck" by China's commitment to "really letting market forces set the path the currency is on." But Mr. Snow made a point of emphasizing that "we will monitor China's 'managed float'" -- as China's new system was being called -- to see whether Beijing makes good on that pledge. Federal Reserve Chairman Alan Greenspan told Congress yesterday it was "a good first step."
Over the long run, China's change could send major ripples through global financial markets. And while American officials had pushed hard for a move by the Chinese, the impact may not be entirely beneficial to the U.S. One worrisome scenario: If China as a result of its change slows its huge purchases of U.S. dollars and U.S. bonds, American interest rates could be forced higher. A China no longer tying its currency solely to the dollar presumably wouldn't have quite so much appetite for constantly buying dollars and bonds to keep its own currency from rising.
Indeed, China's move sparked a broad-based selloff in the U.S. dollar and Treasury notes (http://online.wsj.com/page/0,,2_0031,00.html?mod=2%5F0031) yesterday. That meant the 10-year Treasury note's yield moved higher, to 4.28% from 4.17%. If rates were to go significantly higher in the future, the change could restrain U.S. consumption, the housing market and ultimately global growth. A significantly stronger Chinese currency could also lift the price, in dollar terms, of Chinese exports to the U.S., from clothing to toys to machinery, and to that extent feed inflation.
U.S. stocks (http://online.wsj.com/article/0,,SB112194491160491974,00.html?mod=article-outset-box) gyrated yesterday, affected both by the Chinese news and by word of new London bombings. The Dow Jones Industrial Average finished down a little more than 61 points.
China's decade-long insistence on keeping its currency at a fixed rate to the dollar -- even as vast amounts of dollars flowed into China to buy Chinese manufactured goods -- had become a major trans-Pacific irritant in recent years. The policy meant that Chinese goods were more affordable abroad and therefore Chinese manufacturers had an easier time undercutting American competitors. In response, congressmen and senators have been threatening to impose across-the-board tariffs against Chinese goods to create what they considered a more level playing field.
Beyond America's swelling trade deficit with China, the fixed currency became a symbol of a Chinese government that was taking advantage of the world's free-trading economic system but refusing to play fully by the rules. China's modest step yesterday is the latest in its gradual integration into the world economy, which began in 1978. This opening-up has included welcoming hundreds of billions of dollars in foreign investment, unleashing private companies and entrepreneurs inside China, and joining the World Trade Organization.
China's concerns about the diplomatic sensitivity of its currency policy were evident as officials gave the Bush administration a general heads-up in recent days that some steps were coming soon, though without sharing the exact nature or timing. Many believe the issue was brought to a head by a planned September visit by Chinese President Hu Jintao to Washington and a desire for the issue not to sully the visit. President Bush this week reiterated his desire to see the yuan, which is also known as the renminbi, rise in value against the dollar.
Under the new currency system, China has not surrendered control of the currency. It has moved away from a fixed exchange rate but not all the way to a flexible or free-floating one. It says it will continue to manage its currency, but manage it with an eye toward its value as measured against a basket of currencies, letting the markets have more say.
Limited Daily Moves
China's central bank had for years bought enough dollars to keep the yuan pegged at about 8.28 to a U.S. dollar. In yesterday's move, it let the currency appreciate to 8.11 yuan to a dollar. Now China will limit the yuan's move each day to plus or minus 0.3% against the dollar. It will also allow the yuan to move by a degree it didn't specify against a handful of other currencies independent of its moves against the dollar. The government isn't saying the currency will move every day, or how much it will move over time.
Details of the basket setup will apparently be kept secret, since Beijing didn't say which currencies will be included. At the onset, the U.S. dollar is likely to remain most important. While it isn't clear just how much further China will allow its currency to appreciate, some economists see yesterday's decision as the start of a gradual move up in the yuan. J.P. Morgan Chase predicted the yuan will gain a further 5% by year-end.
The announcement didn't change China's strict control over money flows into and out of the country. The body of rules dictating who can hold foreign currency in China and when are considered so complex that many foreign law firms have at least one specialist covering that area for clients. In recent years, Beijing has relaxed some restrictions on currency inflows such as foreign direct investment.
China also has enacted a program to let foreigners invest in its domestic stock markets, and the total quota was recently raised to $10 billion. Earlier this year, China also said it would let domestic insurers invest in overseas stocks, a move seen as a small step toward easing restrictions on outflows.
If the new currency policy works, it will mark a dramatic step for China toward becoming part of the world economic system while still remaining attractive to foreign companies. Ending the peg to the dollar gives Chinese officials much more flexibility to adjust their domestic economy -- to attack inflation or bail out troubled banks -- without throwing the exchange-rate out of sync. China's central bankers now can adjust the exchange rate against currencies other than just the dollar.
Manufacturers' Reaction
American manufacturers and labor unions hope the change will help U.S. factory sales and jobs by making U.S. goods a little more affordable abroad. The National Association of Manufacturers, which long has lobbied for a get-tough policy on China, greeted the announcement as vindication. "While the initial 2.1% revaluation is inadequate, we view it as the beginning of what should be a significant revaluation," said John Engler, the association's president. "China's new system appears to allow revaluing the yuan as much as three-tenths of a percent each day, meaning it could move as much as 1% every three days."
At Caterpillar Inc., the big Peoria, Ill., producer of heavy equipment, investor-relations chief Mike DeWalt said, "We think the action hey take was good, and we are supportive." He added, however, that the small immediate strengthening of the yuan "is not going to have a very significant effect at all on our results."
Up until now, China delayed making even a minor currency change, largely out of fear that behind the foreign-financed factories that have fed its export boom lay a shaky financial system and inefficient domestic firms. But for China the move may create as many risks as benefits.
One is that currency speculators who have been betting on an upward revaluation of the yuan now will simply double their bets, figuring that if Beijing bowed to international pressure once it may do so again. Some speculators are betting that in view of lopsided trade flows, the yuan remains undervalued versus the dollar by as much as 30%.
"The risk is that they have more capital inflow, creating an expectation of a further move," said Nicholas Lardy of the Institute of International Economics in Washington, one of the leading U.S. economists on Chinese currency issues. "The body language is that they are going to do more later."
China has seen billions of dollars in capital inflows in anticipation of a yuan move, and Chinese companies have been borrowing in dollars in anticipation of a currency-system change. (A cheaper dollar would make the debts easier to pay off.) "If those trends are accelerated, the challenges for the Chinese central bank become bigger rather than smaller," Mr. Lardy said. So many dollars chasing yuan could increase market pressure on the currency and create a self-fulfilling prophecy, if the Chinese really do allow the market to significantly guide exchange rates.
There's another possible side effect. Just as the rapid appreciation of the Japanese yen in the 1970s and 1980s gave Japanese companies incentive to go on an overseas shopping spree, so a strengthening yuan could accelerate Chinese purchases of foreign companies, as well as natural resources. Already, Chinese bids for Unocal Corp. and Maytag Corp. have stirred unease both in the U.S. Congress and among many Americans.
A Big Bondholder
Then there's the opposite risk that China, by diversifying its currency holdings away from the dollar, would reduce its capital flows into the U.S. China has become the second-largest holder of U.S. debt, now valued at more than $190 billion. That may have less to do with Chinese efforts to set the yuan's value than with the mammoth American appetite for borrowing -- both by the federal government and by U.S. households. The Chinese policy shift could eventually cut back the amount of available credit and push up U.S. interest rates.
China also faces political risks from its move. Western policy makers and companies angered by China's past currency policy could conclude over time that yesterday's move was more symbolic than real, resulting in a backlash. "I personally thought it was anemic and needed to go much further," said Keith Busse, chief executive of Fort Wayne, Ind.-based Steel Dynamics Inc. "I guess we all welcome even a baby step."
Bush administration officials have been very careful about managing the politics of China's currency on both sides of the Pacific. Messrs. Snow and Greenspan apparently had enough of a hint from Beijing that a move was coming that they were able to put off a vote on retaliatory legislation to impose a 27.5% tariff on Chinese imports into the U.S. unless China moved on its currency. While the Chinese, according to the Treasury, never asked the administration explicitly to quash the Senate bill, Beijing made clear that it did not intend to be seen as giving in to U.S. pressure.
In deciding how to revamp their currency system, Chinese leaders appear to be adopting some of what their experts learned in study trips to Singapore. That nation has some of the shrewdest financial management in Asia. Since 1981 it has used a so-called managed float, a middle path between a hard peg to another currency and the U.S. approach of just letting the currency float freely as market forces dictate.
The Singapore central bank each day sets a band limiting its currency's permitted moves against a basket of currencies. That way it can make small, unannounced changes in the value of the currency against those of any of its trading partners, depending on economic conditions. By not announcing what is in the basket, the central bank discourages speculators from trying to push the exchange rate up or down.
That approach could be a good compromise for China, allowing it to slowly allow its currency to appreciate, as its trading partners demand, but not lose control of it. The approach gives Beijing more freedom to use its currency policy to help its domestic economy. The system has worked for Singapore. Between 1988 and 1997, Singapore's economy grew at a fast clip, about 9.2% annually. But by letting its exchange rate slowly appreciate, Singapore kept inflation to an average of only 2.4% over the period.
Many Asian nations have been trying to compete with China's low-cost powerhouse and worked to keep their own currencies from rising against the dollar. Shortly after China's announcement, Malaysia announced it would drop its own peg to the U.S. dollar. Hong Kong, however, said its peg to the dollar will remain.
The currency move will make Chinese exports a little more expensive abroad. Textile exporter Shanghai Flying Horse Import & Export Trading Co. said it will raise prices 2% for new contracts immediately. "China's textile companies have no ability any longer to bear costs on our own. If the [yuan] moves up, our prices will have to move up as well," said General Manager Lu Longsheng. But he added he thinks most customers won't flee but will understand the price move.
http://i3.photobucket.com/albums/y72/W_W/Forum/yuan.gif
Let me know if you want any more info from this box outline. http://i3.photobucket.com/albums/y72/W_W/WW.gif
China Lets Yuan Rise vs. Dollar, Easing Trade Tensions Slightly
Amid Pressure From U.S., Beijing Links Economy More to Market Forces Greenspan: 'Good First Step'
By James T. Areddy in Shanghai, Mary Kissel in Hong Kong, and Andrew Browne and Michael M. Phillips in Washington July22,2005
China announced a long-awaited currency-policy change with broad symbolic significance, integrating the nominally Communist nation more deeply into global markets and helping ease tensions with trading partners.
The People's Bank of China revalued the yuan to make the Chinese currency effectively 2.1% stronger against the American dollar than it had been for years. That went part way to satisfy critics who say the yuan has long been significantly undervalued, making Chinese goods cheaper abroad and thus giving the Chinese an unfair trading advantage.
The question is whether the move will be enough -- both to give Beijing's economic stewards the flexibility to deal with weaknesses in their own economy and to quell rising anti-Chinese sentiment around the world.
The answer hinges a lot on just how flexible Chinese currency policy really becomes. The announcement on state television Thursday night in Beijing, at about 7 a.m. New York time, didn't say.
China said it would no longer peg the yuan's value only to the dollar, instead allowing it to trade within a narrow band against a basket of currencies. But just how much the yuan's value will be market-driven, as opposed to government-driven, remains unclear. As the central bank put it in its statement, the Chinese government will act "with a view to establish and improve the socialist market economic system."
The result was a cautious response from American policy makers who have long been prodding China to act. "I think it's the start of an awfully important process," said Treasury Secretary John Snow. Speaking to reporters, he said he was "particularly struck" by China's commitment to "really letting market forces set the path the currency is on." But Mr. Snow made a point of emphasizing that "we will monitor China's 'managed float'" -- as China's new system was being called -- to see whether Beijing makes good on that pledge. Federal Reserve Chairman Alan Greenspan told Congress yesterday it was "a good first step."
Over the long run, China's change could send major ripples through global financial markets. And while American officials had pushed hard for a move by the Chinese, the impact may not be entirely beneficial to the U.S. One worrisome scenario: If China as a result of its change slows its huge purchases of U.S. dollars and U.S. bonds, American interest rates could be forced higher. A China no longer tying its currency solely to the dollar presumably wouldn't have quite so much appetite for constantly buying dollars and bonds to keep its own currency from rising.
Indeed, China's move sparked a broad-based selloff in the U.S. dollar and Treasury notes (http://online.wsj.com/page/0,,2_0031,00.html?mod=2%5F0031) yesterday. That meant the 10-year Treasury note's yield moved higher, to 4.28% from 4.17%. If rates were to go significantly higher in the future, the change could restrain U.S. consumption, the housing market and ultimately global growth. A significantly stronger Chinese currency could also lift the price, in dollar terms, of Chinese exports to the U.S., from clothing to toys to machinery, and to that extent feed inflation.
U.S. stocks (http://online.wsj.com/article/0,,SB112194491160491974,00.html?mod=article-outset-box) gyrated yesterday, affected both by the Chinese news and by word of new London bombings. The Dow Jones Industrial Average finished down a little more than 61 points.
China's decade-long insistence on keeping its currency at a fixed rate to the dollar -- even as vast amounts of dollars flowed into China to buy Chinese manufactured goods -- had become a major trans-Pacific irritant in recent years. The policy meant that Chinese goods were more affordable abroad and therefore Chinese manufacturers had an easier time undercutting American competitors. In response, congressmen and senators have been threatening to impose across-the-board tariffs against Chinese goods to create what they considered a more level playing field.
Beyond America's swelling trade deficit with China, the fixed currency became a symbol of a Chinese government that was taking advantage of the world's free-trading economic system but refusing to play fully by the rules. China's modest step yesterday is the latest in its gradual integration into the world economy, which began in 1978. This opening-up has included welcoming hundreds of billions of dollars in foreign investment, unleashing private companies and entrepreneurs inside China, and joining the World Trade Organization.
China's concerns about the diplomatic sensitivity of its currency policy were evident as officials gave the Bush administration a general heads-up in recent days that some steps were coming soon, though without sharing the exact nature or timing. Many believe the issue was brought to a head by a planned September visit by Chinese President Hu Jintao to Washington and a desire for the issue not to sully the visit. President Bush this week reiterated his desire to see the yuan, which is also known as the renminbi, rise in value against the dollar.
Under the new currency system, China has not surrendered control of the currency. It has moved away from a fixed exchange rate but not all the way to a flexible or free-floating one. It says it will continue to manage its currency, but manage it with an eye toward its value as measured against a basket of currencies, letting the markets have more say.
Limited Daily Moves
China's central bank had for years bought enough dollars to keep the yuan pegged at about 8.28 to a U.S. dollar. In yesterday's move, it let the currency appreciate to 8.11 yuan to a dollar. Now China will limit the yuan's move each day to plus or minus 0.3% against the dollar. It will also allow the yuan to move by a degree it didn't specify against a handful of other currencies independent of its moves against the dollar. The government isn't saying the currency will move every day, or how much it will move over time.
Details of the basket setup will apparently be kept secret, since Beijing didn't say which currencies will be included. At the onset, the U.S. dollar is likely to remain most important. While it isn't clear just how much further China will allow its currency to appreciate, some economists see yesterday's decision as the start of a gradual move up in the yuan. J.P. Morgan Chase predicted the yuan will gain a further 5% by year-end.
The announcement didn't change China's strict control over money flows into and out of the country. The body of rules dictating who can hold foreign currency in China and when are considered so complex that many foreign law firms have at least one specialist covering that area for clients. In recent years, Beijing has relaxed some restrictions on currency inflows such as foreign direct investment.
China also has enacted a program to let foreigners invest in its domestic stock markets, and the total quota was recently raised to $10 billion. Earlier this year, China also said it would let domestic insurers invest in overseas stocks, a move seen as a small step toward easing restrictions on outflows.
If the new currency policy works, it will mark a dramatic step for China toward becoming part of the world economic system while still remaining attractive to foreign companies. Ending the peg to the dollar gives Chinese officials much more flexibility to adjust their domestic economy -- to attack inflation or bail out troubled banks -- without throwing the exchange-rate out of sync. China's central bankers now can adjust the exchange rate against currencies other than just the dollar.
Manufacturers' Reaction
American manufacturers and labor unions hope the change will help U.S. factory sales and jobs by making U.S. goods a little more affordable abroad. The National Association of Manufacturers, which long has lobbied for a get-tough policy on China, greeted the announcement as vindication. "While the initial 2.1% revaluation is inadequate, we view it as the beginning of what should be a significant revaluation," said John Engler, the association's president. "China's new system appears to allow revaluing the yuan as much as three-tenths of a percent each day, meaning it could move as much as 1% every three days."
At Caterpillar Inc., the big Peoria, Ill., producer of heavy equipment, investor-relations chief Mike DeWalt said, "We think the action hey take was good, and we are supportive." He added, however, that the small immediate strengthening of the yuan "is not going to have a very significant effect at all on our results."
Up until now, China delayed making even a minor currency change, largely out of fear that behind the foreign-financed factories that have fed its export boom lay a shaky financial system and inefficient domestic firms. But for China the move may create as many risks as benefits.
One is that currency speculators who have been betting on an upward revaluation of the yuan now will simply double their bets, figuring that if Beijing bowed to international pressure once it may do so again. Some speculators are betting that in view of lopsided trade flows, the yuan remains undervalued versus the dollar by as much as 30%.
"The risk is that they have more capital inflow, creating an expectation of a further move," said Nicholas Lardy of the Institute of International Economics in Washington, one of the leading U.S. economists on Chinese currency issues. "The body language is that they are going to do more later."
China has seen billions of dollars in capital inflows in anticipation of a yuan move, and Chinese companies have been borrowing in dollars in anticipation of a currency-system change. (A cheaper dollar would make the debts easier to pay off.) "If those trends are accelerated, the challenges for the Chinese central bank become bigger rather than smaller," Mr. Lardy said. So many dollars chasing yuan could increase market pressure on the currency and create a self-fulfilling prophecy, if the Chinese really do allow the market to significantly guide exchange rates.
There's another possible side effect. Just as the rapid appreciation of the Japanese yen in the 1970s and 1980s gave Japanese companies incentive to go on an overseas shopping spree, so a strengthening yuan could accelerate Chinese purchases of foreign companies, as well as natural resources. Already, Chinese bids for Unocal Corp. and Maytag Corp. have stirred unease both in the U.S. Congress and among many Americans.
A Big Bondholder
Then there's the opposite risk that China, by diversifying its currency holdings away from the dollar, would reduce its capital flows into the U.S. China has become the second-largest holder of U.S. debt, now valued at more than $190 billion. That may have less to do with Chinese efforts to set the yuan's value than with the mammoth American appetite for borrowing -- both by the federal government and by U.S. households. The Chinese policy shift could eventually cut back the amount of available credit and push up U.S. interest rates.
China also faces political risks from its move. Western policy makers and companies angered by China's past currency policy could conclude over time that yesterday's move was more symbolic than real, resulting in a backlash. "I personally thought it was anemic and needed to go much further," said Keith Busse, chief executive of Fort Wayne, Ind.-based Steel Dynamics Inc. "I guess we all welcome even a baby step."
Bush administration officials have been very careful about managing the politics of China's currency on both sides of the Pacific. Messrs. Snow and Greenspan apparently had enough of a hint from Beijing that a move was coming that they were able to put off a vote on retaliatory legislation to impose a 27.5% tariff on Chinese imports into the U.S. unless China moved on its currency. While the Chinese, according to the Treasury, never asked the administration explicitly to quash the Senate bill, Beijing made clear that it did not intend to be seen as giving in to U.S. pressure.
In deciding how to revamp their currency system, Chinese leaders appear to be adopting some of what their experts learned in study trips to Singapore. That nation has some of the shrewdest financial management in Asia. Since 1981 it has used a so-called managed float, a middle path between a hard peg to another currency and the U.S. approach of just letting the currency float freely as market forces dictate.
The Singapore central bank each day sets a band limiting its currency's permitted moves against a basket of currencies. That way it can make small, unannounced changes in the value of the currency against those of any of its trading partners, depending on economic conditions. By not announcing what is in the basket, the central bank discourages speculators from trying to push the exchange rate up or down.
That approach could be a good compromise for China, allowing it to slowly allow its currency to appreciate, as its trading partners demand, but not lose control of it. The approach gives Beijing more freedom to use its currency policy to help its domestic economy. The system has worked for Singapore. Between 1988 and 1997, Singapore's economy grew at a fast clip, about 9.2% annually. But by letting its exchange rate slowly appreciate, Singapore kept inflation to an average of only 2.4% over the period.
Many Asian nations have been trying to compete with China's low-cost powerhouse and worked to keep their own currencies from rising against the dollar. Shortly after China's announcement, Malaysia announced it would drop its own peg to the U.S. dollar. Hong Kong, however, said its peg to the dollar will remain.
The currency move will make Chinese exports a little more expensive abroad. Textile exporter Shanghai Flying Horse Import & Export Trading Co. said it will raise prices 2% for new contracts immediately. "China's textile companies have no ability any longer to bear costs on our own. If the [yuan] moves up, our prices will have to move up as well," said General Manager Lu Longsheng. But he added he thinks most customers won't flee but will understand the price move.
http://i3.photobucket.com/albums/y72/W_W/Forum/yuan.gif
Let me know if you want any more info from this box outline. http://i3.photobucket.com/albums/y72/W_W/WW.gif